Death Spirals and Toxic Converts

The term Death Spiral funding became popular in the late 1980's and early 1990's. It is a term used to describe a convertible security that converts at a discount to the market price at the time of conversion, but HAS NO FLOOR PRICE PROTECTION.

This type of funding is also referred to as a toxic convertible or floorless convertible since the investor can keep converting below the market which in many instances can greatly dilute the companies shareholders and continually drive the price of the shares down.

If your company is considering this type of funding be very careful you have a back-up plan. A good solution for most companies is to find a long term funding source for Special Private Placement Agreements or "SPPA". This funding structure is being used by many listed companies all over the world on various stock exchanges. SPPA is used to fund large and small companies over a period of several years. It allows the company to use a floor price feature to protect its current shareholders, yet at the same time provide necessary funding to the company to aid in its overall expansion and growth plans.

Exceptions to why a company would do toxic convertible funding would include two scenarios:

Scenario One: The company has funding lined up and is basically doing the death spiral funding to gain ninety days while they are closing on another form of funding they have lined up with another investor or lender. They company feels within the ninety day period the new funding will be obtained and it can be used to pay off the toxic funding. So in other words, this is a gamble the company is willing to take to line up the other funding.

Scenario Two: The company needs the death spiral funding to meet pending orders and that will provide sufficient cash flow to pay off most if not all of the toxic funding that is being offered to them now. Again, in this situation the company feels they can pay off the toxic funding after they fill their orders and gain valuable market share and expand their customer base. Again this is a calculated gamble the company is willing to take, but they should only do so after careful consideration of all the relevant factors.

It would be much simpler to obtain an SPPA in most cases.


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Alvin Donovan, Managing Director Equity Partners Fund SPC, bestselling author, hedge fund industry pioneer, completed several billion dollars transactions, consultant to fortune 500 companies, faculty member most of the world's largest management institutes, raised over USD$1.5 billion for funds
http://www.alvindonovan.com